De-jargoned | Solvency ratio

A lot of customers still remain apprehensive about buying an insurance policy from a private insurance company. This apprehension stems from the belief that since these insurers are susceptible to market risk and don’t have the backing of the government, the insurers will find it difficult to service their liabilities of paying claims and maturity benefits in extreme economic condition. However, except for a doomsday scenario, insurers are equipped to handle downturns. That’s because of a cushion called the solvency margin.

Insurers in India are regulated and so, among other things, the Insurance Regulatory and Development Authority mandates that all insurers must maintain a minimum solvency margin. Put simply, it is the margin of assets a company owns over its liabilities. This solvency margin gets reflected in the solvency ratio. Understand what solvency ratio means and put your fears to rest.

What is solvency ratio?

In India, insurers are required to maintain a solvency ratio of 150% at all times. But it is not as simple as having assets 1.5 times the liability. What it means is that the ratio of the actual solvency margin to the required solvency margin needs to be 150%.

Solvency margin: Let’s understand solvency margin first. Solvency margin is the margin of assets over liabilities. Assets for the insurance company would broadly mean fixed and investment assets, whereas liability would mean future payouts (read costs such as claims, surrender benefits and maturity benefits) and other expenses that the company will need to pay. Based on future projections of these payouts, an insurer will arrive at its liability.

How does the cushion work? For each class of product, depending upon the inherent risk of the product, Irda has prescribed a method to arrive at the required solvency margin. Let’s say, insurer A has a liability of Rs.100 and arrives at a solvency margin of say Rs.10. This means the required assets should be worth Rs.110. But in order to provide a further cushion to this number, Irda has prescribed a solvency ratio of 150%, which means the insurer will need to maintain Rs.115 instead of just Rs.110.

Does high solvency mean high safety?

So does that mean that a company with very high solvency ratio is safer than the rest? Not really. A high solvency ratio could also mean that the company is hoarding capital instead of making use of it. You needn’t worry much about the company’s ability to discharge its duties but its intention to do so can always be questioned.